The politics of climate change. Are you ready?

In the next few weeks the Government will release its response to the challenge of climate change. This will be a significant policy with the potential to affect every business and every consumer in the country. This is the first paper in a two-part series. The second paper will be released after the government announcement and will offer an in-depth analysis of the proposed regime.

The Prime Minister has already indicated she wants the policy to position New Zealand as both "pace-setter" and "pathfinder". "If we can get it right that sets a model for others as well", she said recently.

But what does getting it right look like? And what if we get it wrong?

The Government’s initiative, led by Minister for Climate Change David Parker, is expected to be an "all sectors in, no exemptions" carbon cap and trading system.

This is a centralised solution, whereby a limit is set on the quantity of emissions and the right to emit is distributed through a system of tradeable permits.

The model proposed is mainstream, but the practicalities surrounding the establishment, enforcement and impact of the regime remain problematic. There will also be controversy around the speed at which the Government plans to introduce the cap and trade system.

The whole issue of climate change is moving at speed. Yet as it gathers momentum uncertainty increases about what climate change policy responses will mean in practice.

For businesses this creates a suite of new risks that include:

increased regulation

climate change litigation

shareholder activism

negative public perception

Many New Zealand businesses are now pro-actively seeking to manage their climate change profile but it is early days. With no clear government policy on climate change mitigation, corporates have had to improvise a response. This is about to change.

Given the scope and potential impact of the initiative the Government has in mind we urge you to take an interest in the development of this policy. To assist you Chapman Tripp has prepared this paper, canvassing some of the wider issues at play in the current debate.

The Government’s timetable

Once released, and assuming the Government has the numbers in the House, events will move quickly.

Proposal due before Cabinet in August.

Draft policy released for limited consultation.

Final policy unveiled in September/October.

Bill introduced in the House in October.

Act passed by March 2008.

Trading underway by the late 2008.

This is ambitious for any government, let alone a minority government. By comparison, Australia is also moving towards a cap and trade regime, but over a four-year timeframe.

What is carbon trading?

It is like a commodity market, only what is being traded does not exist. The trade is not actually in carbon, it is in not-carbon. The market works by setting a cap on total emissions, establishing a price for carbon and then allowing emitters to purchase credits from other companies. Credits can be traded or banked.

There is already a trading market in Europe (the European Emissions Trading Scheme, ETS) and in the United States (the Chicago Climate Exhange, CCX). The CCX traded 1.8 million metric tons of CO2 in May alone.

Why now?

Politicians of all stripes sense a tipping point has been reached. Right now governments, opposition parties and businesses all over the world are struggling to keep up with what has been a monumental shift in public attitude. The debate is no longer about the science, it is about the solution.

The need to settle on a solution and then create consensus around its suitability is also becoming more urgent. As noted above, New Zealand is currently lagging behind the US and Europe where carbon trading already occurs. In Australia plans are being developed for a carbon trading regime and the Federal Government is drafting legislation to force companies to report their greenhouse gas emissions from July 2008.

In the US and Australia the first climate change law cases have been filed against companies accused of being major emitters of greenhouse gases. Activists in the US especially are talking of climate change as the next asbestos or tobacco.

In New Zealand Greenpeace has recently hired an Australian law firm to serve "legal notice" on 20 local companies, threatening possible legal action if their greenhouse emissions are not reduced.

Is carbon trading the solution?

The jury is out on that. The Economist recently called cap and trade "the second best route". It favours carbon taxes. However a carbon tax can never provide certainty that the level of emissions will reduce. What if consumers show they are simply willing to pay to pollute?

Internationally there is momentum developing around emissions trading, although there is still debate about what kind trading regime might work best.

There are many uncertainties.

At what level do you set the cap and therefore the price per unit?

How are the tradeable units allocated at the outset? Are they freely given out or auctioned off?

How many permits are granted? (Get this wrong and permit prices could either be very steep or virtually worthless.) And will the number of permits be fixed or adjusted depending on the state of the economy? (Companies produce fewer emissions during a recession, naturally enough.)

How are emissions monitored and verified?

How do we make sure the cap and trade route results in costs being passed down so that emissions behaviour changes?

How closely will New Zealand link with the international emissions trading market? (Internationally the price of permits has been very volatile. Assuming the cost of compliance is passed down to consumers, what impact would sharp peaks and deep troughs in price have on our economy?)

Do we attempt to mark our progress against the pace of our main competitors? Or do we plot our own path regardless of their climate change policies?

How do we balance the interests of Brand New Zealand with the interests of individual businesses trying to compete globally? How do we ensure local businesses remain here, rather than relocating to other states that are more tolerant of emissions?

How do we treat importers?

Life After Kyoto

The Government’s proposed cap and trading regime is quite distinct from any commitments under the Kyoto Protocol, but the approach favoured by the Government will have an impact on what comes after Kyoto. Some commentators are even suggesting New Zealand’s carbon trading policy design could have a disproportionate impact on the evolution of whatever agreement comes next (assuming of course an international agreement can be reached).

Kyoto established a global cap for emissions and legally bound member nations to reduce emissions by set targets.

New Zealand has always been an enthusiastic supporter. Under Kyoto, we are legally bound to reduce our greenhouse gases to 1990 levels between Jan 1 2008 and December 31 2012. Those commitments currently look unattainable which means from next year New Zealand faces a penalty bill that Treasury estimates could be as high as $567m (The National Party claims it could be up to $1.7b).

Kyoto has always been less than perfect. It never bound developing countries to cut emissions. Both the United States and Australia refused to ratify the Protocol. And among Kyoto supporters few have so far shown signs of meeting their emissions targets, including Britian (a staunch pro-Kyoto campaigner) where emissions have actually increased.

Here’s a sobering reality check; Since Kyoto was drawn up in 1997 India and China have together built 800 new coal-fired plants which will emit five times the total reduction of greenhouse gases foreseen by the Protocol.

Internationally attention has now shifted to focus on what happens post-Kyoto. Significantly the two countries most critical of Kyoto, the US and Australia, are taking a lead in this conversation. As they do, debate is coalescing around two starkly different camps.

Kyoto II; where a new global emissions cap is set and countries are legally bound to meet targets

New approach; no global cap is set and individual countries set and reset their own targets as circumstances dictate within a global framework whereby there are mutual expections emissions will be reduced.

Both approaches forsee some kind of international framework and the negotiation of bi-lateral agreements to trade. The first includes timelines and a focus on emissions targets; the second takes a more holistic view.

The first approach is favoured by the Europeans, whose own cap and trading system is now well established.

Australian PM John Howard is positioning himself as the champion of the second scenario.

In a recent speech Howard characterised Kyoto as being "top down, presumptive, legalistic and Euro-centric". Its successor, he said, should be "bottom-up, cooperative and flexible".

The flexible approach he favours he has called "pledge and review". The pledge involves (probably) setting lower emissions targets, but supplemented by other obligations such as the up-take of specific energy-efficient technology. All of these obligations are reviewed and amended according to prevailing circumstances.

It is not yet clear which of these two approaches New Zealand will support.

New Zealand seems keen to position itself as a key player in a potential Asia Pacific emissions trading bloc. But does this mean the New Zealand design must be the same as Asia’s and Australia’s, or just compatible with theirs? John Howard’s cap and trade regime is to be decidedly Australian made, with no externally imposed cap acceptable. Likewise he claims the emerging Asian economies will not tolerate a top-down regime. New Zealand’s problem is that to date, at least, it has been closely associated with the Kyoto model, even when it hurt. And the Clark Government continues to foster close links with Europe, and to look to the European model for guidance. But at the same time Helen Clark and John Howard recently agreed to work together to ensure both Australia and New Zealand come up with trading regimes that are compatible.

It may be that an international accord cannot be found. European and Asian foreign ministers agreed earlier this year to a 2009 deadline for a new international agreement. Negotiations begin in Bali in November 2007. If there is no accord New Zealand may have to choose in whose camp its interests best lie.

The growth factor

Earlier this year the Prime Minister said, "More than any other developed nation, New Zealand needs to go the extra mile to lower greenhouse gas emissions and increase sustainanility". She has stated her Government aims to make New Zealand carbon neutral. She has not defined what that means in practice.

As yet there has been no public debate about what implications this initiative might have on either the New Zealand economy or the New Zealand way of life.

David Parker has said the cost of meeting New Zealand’s international obligations to reduce greenhouse gases will be equal to about 0.1% of GDP, although that assertion has yet to be tested.

In a speech in June he stated that one of the Government’s objectives was to "de-link emissions and economic growth". But can the two be de-linked? Can an economy grow and emit less CO2 into the air? The data to date has shown a complete correlation between low emissions and low functioning economies. This could well be the ultimate challenge.

The race to reduce emissions will create opportunities for new technologies and innovation. But a meaningful reduction in emissions must ultimately have an impact on economic growth. When do we acknowledge this? And how do we manage the adjustment?

Is this a case of TINA?

In the late 1980s and early 1990s, when challenged about their radical prescription, the economic liberals used to claim "there is no alternative". The catchcry became known as TINA.

The Clark Government is framing its response to climate change at a time when all governments have no alternative but to do something.

Consumers have fast latched on to the issue and in a myriad of small and medium-sized initiatives both governments and corporates are tapping into this consumer interest and anxiety, inadvertantly reinforcing and fostering it.

Here’s just a sample.

Britain’s Department of Culture, Media and Sports has circulated a healthy living kit to primary schools which includes a section entitled, "The Problem with Food Miles". It encourages children to think about where their food comes from. "Could you grow this in the UK?" it asks.

The UK Soil Association which certifies organic food is considering placing a ban on all air-freight food.

Tescos, the giant UK supermarket chain, has begun identifying all air-freighted food with a small plane sticker so consumers can make informed decisions about purchase. (The stickers have been used for less than three months and to date there is no evidence sales have been affected.)

The Australian Government is about to spend A$23 million on a public awareness campaign "to create a sense of urgency about the issue".

As an indication of popular interest, on YouTube there are currently 18,200 postings on global warming.

Until such a time as consumer sentiment turns (if it does) no politician can ignore this kind of groundswell. To do so is to hand votes to your opponent.

Getting smart

New Zealand is geographically remote, far removed from our markets and dependent on export and tourism for our well-being. We market ourselves as pure and clean, terms that will take on new meaning in the post-Kyoto environment.

The next few months will be a crucial time in the development of a smart solution to the climate change challenge.

The Clark Government is looking for a bold positioning policy with the potential to win over both voters at home and consumers abroad. Given its likely impact, over the short, medium and long term we advise you to take an interest.